In June and July, Pennsylvania and Washington quietly became the first two states in the nation to explicitly list non-fungible tokens (NFTs) as digital assets subject to sales and use taxes. While Pennsylvania’s Department of Revenue inaugurated the change by adding NFTs to its “taxability matrix” without providing any accompanying guidance, Washington published an interim statement with definitions of key terms and a proposed schema for determining the “sourcing” of NFTs, or where, for tax purposes, related transactions physically take place.
The key complication in taxing NFTs is that the current ecosystem is notoriously murky when it comes to the identities of buyers and sellers, down to where they are located. Moreover, some states currently acknowledge that NFTs may be taxable (even if they have not formally listed them as of yet) while others do not.
The administration of sales taxes has been confounding for state regulators since the dawn of e-commerce, which confronted them with unprecedented questions surrounding how to treat Internet sales. A key Supreme Court case in 2018, South Dakota v. Wayfair, altered the landscape of state taxation for digital transactions by ruling that sellers did not have to have a physical presence in any given state where purchasers receive goods to impose taxes on sales, once they achieve a certain volume of transactions. Ostensibly, according to the logic of that case, NFT vendors should be held to the same standard and are obligated to collect sales taxes when doing business with customers in states that tax digital assets.
Federally, taxation rules surrounding NFTs are also incomplete. The Internal Revenue Service (IRS) has recognized cryptocurrency as property since 2014; any gains made from its use are liable to taxation. As part of the Infrastructure Investment and Jobs Act signed into law in November 2021, President Biden imposed new reporting requirements for cryptocurrency transactions that would require businesses to collect additional information. The IRS is due to issue further guidelines for the federal taxation of digital assets to specify how these new provisions are to be implemented.
Both Pennsylvania and Washington’s actions surrounding the taxation of NFTs are guidelines that interpret existing law rather than enactments of entirely new legislation. That means that they could be retrospectively applied, with a spokesperson for Pennsylvania’s Department of Revenue stating that it had the power to collect taxes on NFTs going back to 2016.
Washington’s more comprehensive statement suggests that NFT sellers will be expected to document the time and place of each transaction, and possibly the addresses of buyers. It defines NFTs, lays out which kinds of NFTs are taxable, outlines how a vendor would tabulate their tax obligation, and gestures at how vendors might source the sale. The last item is the most ambiguous; currently, few vendors or marketplace platforms track who buyers are and where they’re located because these transactions use cryptocurrency. Some experts think that new rules like Washington’s will transform industry practices by scaling back the anonymity that currently reigns supreme in NFT sales.
Washington’s statement does not constitute a permanent guidance, and the Department of Revenue continues to seek feedback as it develops one.